Our Firm

Why Principles and Performance? An Interview with Parnassus Investments Founder and President Jerome Dodson

When Jerome Dodson established Parnassus Investments in 1984, his mission was to create an investment company that would both express his values through responsible investing and provide good returns to shareholders. Thirty years later, ESG (environmental, social and governance) investing is widely accepted, and Parnassus is both an industry leader and the largest ESG mutual fund company in America. Jerome Dodson traces the roots of the firm and explains how Parnassus implements Principles and Performance®.

In 1984, ESG was not something that many people were talking about, but you had the foresight to see its importance. What led to your founding of Parnassus?

In the beginning, I wanted to start a fund that would be values-based. I looked at my own values and wondered if it would be possible to get enough people to invest in such a fund to make it a viable enterprise. As far as I know, there were only two socially responsible funds at that time-Calvert and PAX World-but I had experience with two other financial entities that took social factors into account.

When I was president of a small bank in San Francisco called Continental Savings, we started a program called the Solar T-Bill account that used deposits to finance solar energy. And, much to my surprise, it was a very successful program. This convinced me that if safety, liquidity and yield were comparable, people would prefer to make a positive impact. Next, I was involved in starting Working Assets Money Fund, which invested in debt securities that financed student loans, housing and solar energy. This experience further convinced me that there was a market for values-based investing.

These two personal experiences-Continental Savings and Working Assets—were my sources of inspiration for the Parnassus Funds. However, at that time, many people argued that taking social issues into account was not compatible with successful investing. In the beginning, I wasn't even sure myself, but I was willing to give it a try.

You've described how Parnassus' ESG approach was a key reason for starting the firm. Are there other aspects of the Parnassus investment process that have underpinned the firm's success?

Our process for buying undervalued stocks has helped make Parnassus successful. From the outset, we took into account the financial screens that were first introduced by Benjamin Graham and later enhanced by Warren Buffett.

Our standards are quite rigorous; we put all our energies into finding the best 30 or 40 companies for each portfolio-those with the strongest competitive advantages. We also build models of a company to understand the range of outcomes for the business. We have to have a much higher conviction in each company in the portfolio than we would if we held more stocks. If we held 150 companies in the portfolio, it would be hard to have as much knowledge and conviction about each of the companies.

Our collaboration, which has been built over a long period of time, is an important part-but not the only part-of our success. The Graham and Dodd approach of investing in undervalued stocks is very easy to understand, but it's very difficult to implement, for both intellectual and emotional reasons. People don't want to buy a stock after it's fallen down. You need to have the right temperament to buy a stock when it's down and also have the intellectual capability to determine which stocks have gone down due to short-term factors and should be able to bounce back.

The entire research team participates in qualitative ESG evaluations of companies in five broad areas: environment, community, customers, workplace and governance. In addition, the firm screens out certain potential holdings. How were these ESG screens chosen?

Originally, the screens reflected my values, which became the firm’s values. For instance, there are industries we don’t invest in, because we think they have a negative effect on society. Alcohol, tobacco, weapons and gambling are among them. Alcohol used in moderation is not a negative, but in general alcohol has been a problem for society, which is why we chose to screen alcohol manufacturers out of our investment universe.

Do screens limit the opportunity set?

In the beginning, some people said that, ipso facto, excluding certain companies would mean we would underperform. I was a little concerned early on about whether they were right. But of course, Parnassus has had good returns. The fact that we exclude part of the universe doesn't hurt us because there are still plenty of good companies to invest in. In fact, I think it's helped us rather than hurt us. The track record of the Parnassus Funds, especially the Endeavor Fund, shows that.

I believe the environmental screen and the workplace screen have helped us the most over time. Companies that treat their employees well do better as businesses. Companies that reduce their waste and carefully use resources save money and are less likely to be sued or fined.

Have there been any changes in the countries that are included in the ESG screens?

Parnassus has participated in two industry-wide initiatives to avoid investing in specific countries. South Africa was initially included in the ESG screens due to racial discrimination. When the racial exclusion laws were overturned, we eliminated that screen. We later added Sudan to our screens (with the exception of humanitarian investments) because the ethnic violence in Sudan is so egregious. If this situation improves, I would love to remove the Sudan screen, but it hasn't happened yet.

There are other countries that could be put on the exclusion list, but we would prefer to have the positive influence of business coming into these countries and improving things. So we have excluded countries in just a couple of situations.

Can you explain why Parnassus does not invest in the nuclear power industry?

If the safety issue were resolved, I would be very happy to invest in nuclear power. It is a good source of clean energy. Right now, however, there are serious safety issues with nuclear power, and it's also very expensive, which many people don't realize. But if the problems with safety and cost were successfully addressed, I think we would probably change our viewpoint.

Why do we have allowances for modest exposures of certain prohibited products in our portfolios?

Initially, we didn't have any allowance for companies that produce a small amount of a prohibited product, but this prevented us from investing in good companies that were basically positive because they had an insignificant subsidiary or a small portion of their business in a prohibited area. So we decided to make allowances for very small amounts of business in these prohibited areas.

Other firms screen out industries such as animal testing, adult entertainment and family planning. Why doesn't Parnassus?

We consider many issues that could negatively impact a company's brand, risk and performance that are not included in our formal screens. For example, if animal testing is not used to save lives and not done in a humane way, we will avoid that company. However, we generally avoid laundry lists of excluded areas because they complicate investment decisions.
We don't explicitly prohibit adult entertainment, but I don’t think it will ever appear in our portfolios. If people want to use it, that's an individual choice, but our company isn't in the business of investing in adult entertainment.

With regard to family planning issues, we think it’s up to the woman to make that choice. For example, I don’t think we have invested in a contraceptive business, but I certainly have no objection to that, because it should really be up to the woman to choose.

Are you considering any new exclusionary screens? Maybe marijuana where it’s legal?

In a recent interview, I was asked about marijuana, and I said we certainly have no plans to invest in marijuana. It's still illegal at the federal level, and I personally don’t think it's a good idea to smoke marijuana. If it becomes a legal product and people want to smoke it, that's fine for them. I doubt we would get into that industry, though.

How did ESG investing become so popular?

When we started the Parnassus Fund at the end of 1984, the idea was not popular at all, and our growth initially was very, very slow. At that time, many people argued that taking social issues into account was not compatible with successful investing. Then in the late nineties, people who had come of age in the sixties were starting to get some money. These baby boomers had been sensitized by the political movements of the sixties and seventies, and investor attitudes changed. ESG's popularity became even more pronounced during the past 10 years. Now, there are literally hundreds of funds that take ESG factors into account.

What would happen if everyone started investing like Parnassus? Could our advantage be arbitraged away?

Yes, it could be. It won’t, but it could be. If everybody invested like Parnassus, there would be no premium for investing this way. But it's unlikely that everyone's going to invest like Parnassus, with human nature being what it is. So I don’t think that's a danger anytime soon.

And it's not just the ESG factors that give our funds an edge in performance. It's also the financial factors. It’s buying undervalued stocks. It's looking at the balance sheet. It's looking at the income statement. It's looking at companies that have competitive advantages. All these things are very important. So I think even if the ESG factors we use were arbitraged away, the Parnassus Funds would still have an edge.

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